SEC Chairman Weighs in on the Transition to SOFR

On the heels of remarks by his U.S. Commodity Futures Trading Commission (“CFTC”) counterpart, U.S. Securities and Exchange Commission (“SEC”) Chairman Jay Clayton recently commented on ongoing benchmark reform and the transition to the Secured Overnight Financing Rate (“SOFR”). As we noted earlier this week, Chairman J. Christopher Giancarlo of the CFTC recently advocated for the adoption of SOFR as the appropriate replacement for LIBOR and added that the CFTC is already working on the transition. He implored market participants and firms to immediately begin transacting in SOFR derivatives for the health of the transition.

In remarks on December 6, 2018, Chairman Clayton mentioned the transition away from LIBOR as a market risk that the SEC is currently monitoring. For Chairman Clayton, the key risk stems from the fact that there are approximately $200 trillion in notional transactions referencing the U.S. Dollar LIBOR and that more than $35 trillion will not mature by the end of 2021, when banks currently reporting information used to set LIBOR are scheduled to stop doing so. Listing potential issues with a transition away from LIBOR, Chairman Clayton raised questions such as what happens to the interest rates of the instruments that will not mature before 2021 but reference LIBOR? Does an instrument’s documentation include any fallback language? If not, will consents be required to amend the documentation?

Despite his concerns, Chairman Clayton also spoke positively of SOFR as an alternative benchmark for LIBOR. For instance, because SOFR is based on direct observable transactions (i.e., transactions in the repurchase agreement transaction (“repo”) markets), its underlying markets have deep liquidity (e.g., repo transactions with daily volumes regularly in excess of $700 billion).

Ultimately, Chairman Clayton observed that a lot of progress has been made in the transition from LIBOR to SOFR. Markets have already seen SOFR-based debt issuances, as well as developments in the SOFR swaps and futures markets. However, before settling into SOFR as the new benchmark, Chairman Clayton believes that more work needs to be done to development a SOFR term structure that will facilitate the transition from term-based LIBOR rates.